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China ETFs Slide on Cash Crunch Fear

While the global market heaved a sigh of relief last week with the U.S. risks temporarily averted, China has become a flashpoint where events could either promote global stability or push other markets into a crisis.

Fears of a cash crunch have surfaced once again in the world’s second largest economy as the central bank did not inject liquidity into the economy for the third day in a row. This has resulted in rising money market rates across the nation (read: Top Ranked Emerging Asia-Pacific ETF in Focus).

The seven-day bond repurchase rate, a key gauge of short-term liquidity in China, jumped more than 150 bps in the past two days to nearly 5% after seeing a persistent decline since October 9th. This marks the biggest increase since July and signals that the bank might start tightening its monetary policy in order to prevent rising property prices and growing inflation.

The latest housing data in China suggests that home prices in some major cities have climbed sharply and is a bit out of control, leading to heightened worries over a property bubble. This could aggravate the inflation rate, which is already at a seven-month high (read: Focus on These China ETFs for Outperformance).

Market Impact

The sudden move by the People’s Bank of China to suspend weekly auctions of reverse repurchase agreements had caused jitters across the global markets. The bank generally conducts bi-weekly reverse-repurchase operations on Tuesday and Thursday to provide liquidity to the market.

As such, China ETFs saw horrendous trading yesterday, crushing stocks across the board. Below, we have highlighted three most popular ETFs that have seen rough trading and might continue to do so in the coming days (see: all the emerging Asia Pacific ETFs here).

This fund provides exposure to a small basket of 26 Chinese large cap stocks by tracking the FTSE China 25 Index. The product has over $5.7 billion in AUM and is extremely liquid, trading in volumes of more than 18 million shares a day. FXI charges 74 bps in fees per year from investors.

The ETF is largely concentrated on its top 10 holdings with nearly 60% of total assets going to these companies. In terms of sector holdings, financials dominate the fund with more than 55% share while telecom, oil & gas, and technology provide a decent mix in the portfolio. The fund lost 3.33% yesterday and holds a Zacks ETF Rank of 3 or ‘Hold’ rating.

This large cap focused ETF follows the MSCI China Index, holding 138 securities in its basket. The fund has amassed over $1 billion in its asset base while charging 61 bps in annual fees. Volume is also good as it exchanges roughly 550,000 shares on average for a day.

The product has moderate concentration across its top 10 firms at 51.4% while sector exposure is tilted toward financials at 39%. The ETF was down about 3% yesterday and has a Zacks ETF Rank of 2 or ‘Buy’ rating, suggesting that it will outperform its peers over the next one-year period (read: Time to Buy This China ETF?).

This is also a large cap centric fund offering exposure to a large basket of 241 securities and tracks the S&P/Citigroup BMI China Index. The fund manages assets worth $934.8 million while sees about 200,000 shares in volume a day. The ETF charges 0.59% in expense ratio.

The ETF puts nearly 43% of assets in top 10 holdings, suggesting moderate concentration. Here again, financials take the top spot in terms of sector exposure at 32%, closely followed by information technology and energy. GXC also lost 3% yesterday and has a Zacks Rank of 3 or ‘Hold’ rating.

What Lies Ahead?

The cash crunch may not be as bad as the one we saw in June that rattled global stocks. This is because the central bank aims to maintain relatively steady monetary conditions, neither tight nor loose (read: China ETFs Tumbling on Fears of Credit Crunch).

Additionally, the economy picked up growth in the third quarter, rising 7.8% from 7.5% in the second quarter and 7.7% in the first. Foreign exchange reserves climbed 4.7% to a record $3.66 trillion in the third quarter. This marks the biggest increase in five years.

Driven by modest government stimulus efforts, the remarkable improvement has increased chances of the economy meeting or exceeding the country’s annual growth target of 7.5% this year.

Further, the manufacturing sector, as indicated by the preliminary Markit/HSBC Purchasing Managers Index (PPMIQ), climbed to a seven-month high to 50.9 in October, surpassing 50.2 in September and the market expectation of 50.4.

However, looking at September data, the Chinese economy looks uncertain with falling exports as well as slow growth in industrial production, retail sales and construction activity. This sluggish development might slowdown Chinese growth in the fourth quarter, especially if the central bank scales back liquidity measures.

Given this, investors might want to approach China-focused ETFs with caution, as we could be in for a rough period in this market to close out the year.